Economics

Hedge funds once primary target of GP Stakes, as PE firms take the lead

PitchBook’s latest analyst note devoted to PE focuses on the growing trend of limited partners and other investors taking stakes in PE general partner management companies.

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Key takeaways:

  • GP stake deals are quickly gaining attention as a new investment strategy, with major players such as Goldman Sachs, Dyal Capital Partners, and Blackstone, among others, all raising funds to acquire minority equity positions in the management companies of alternative asset firms.
  • Hedge funds were once the primary target of such investments, but PE firms are now accounting for more than half of all GP stake deals; this trend is likely to continue as more capital is dedicated to strategies that explicitly target PE firms, many of which are using GP stake investments to facilitate succession plans.
  • Because GP stake deals introduce a new participant into the traditional LP-GP relationship, these deals can alter the value proposition and alignment of incentives because GPs now must consider the interests of the minority investor as well as the LPs in their funds.

Introduction

As PE (and the alternative investment industry in general) has continued to evolve and mature, investors have sought new ways to access the asset class. Limited partners (LPs) are increasingly seeking ways to forge tighter relationships with GPs and to gain additional exposure to underlying deals. In recent years, this trend has manifested itself through more customized mandates and a proliferation of co-investments. Now, LPs are taking the next step by formulating investments in the management companies of the GPs themselves.

Prime cut? Defining GP stakes

GP stake deals (also known as a minority stake deals) are similar in structure to seeding a new manager, but there are two major differences.

One key distinction is that seed deals are typically structured as an LP commitment to a fund, whereas a GP stake deal is a direct equity investment in the GP’s underlying management company. Seeding is typically associated with alternative managers operating strategies of greater liquidity, such as hedge funds, that are raising an initial fund and would benefit from a long-term capital commitment. In exchange for the relatively longer lockup of capital, seed investors receive preferential terms on their commitment and get to participate in revenue share with the GP. First-time PE funds often strike similar arrangement with so-called anchor investors, which provide a substantial early commitment to a fund in exchange for special terms, such as reduced fees and a right of first refusal on co-investments.

Investors in GP stake deals enjoy many of the same benefits associated with seeding; however, GP stake investments represent a purchase of a minority (typically non-voting) ownership position in the GP’s underling management company, as opposed to a seeding, which is essentially an LP commitment that includes special privileges. Due to their structural differences, seeding and GP stake deals tend to target managers at different stages of their development. Whereas seed deals generally involve new and emerging managers, the targets in GP stake deals are typically well-established firms with a track record of strong performance.

GPs sell minority positions to generate an influx of cash that can subsequently be used for a variety of purposes, including to execute acquisitions, to provide liquidity to founders and partners, and to fuel the development of new strategies and funds. When raising new funds, GPs need to commit their own capital alongside LPs to ensure they have “skin in the game” and to help align incentives; however, it can be difficult for junior professionals to fulfill this commitment, particularly for larger funds. Some GPs are using the capital raised through GP stake sales to help junior investment professionals bridge this gap. In return for their GP stake investment, LPs receive greater access to the bestperforming managers as well as a portion of future management fees—not to mention the potential for appreciation in their equity stake.

History

A slow start

While GP stake deals have only begun to garner media attention, the strategy has existed in various forms for years. One of the first GP stake deals involved two stalwarts of the industry, with CalPERS acquiring a 10% stake in the Carlyle Group back in 2000. Activity was tepid for the first several years before large asset managers, such as Affiliated Managers Group (AMG) and Asset Management Finance (AMF), entered the space. Both began by investing in several hedge funds: AMG made their first minority investment via a deal with AQR Capital Management in 2004, which was followed by AMF’s first minority investment in Rigel Capital in 2007. During this time, several prominent firms, including Apollo and Carlyle, sold stakes to sovereign wealth funds and other deep-pocketed LPs.

These early explorations, which were executed by a single investor which typically had a longstanding relationship with the GP, paved the way for institutional capital. In 2007, Goldman Sachs’ Alternative Investments & Manager Selection (AIMS) group raised $1 billion for its inaugural Petershill fund to specifically target these types of deals in hedge funds. Neuberger Berman followed suit in 2011, establishing a new unit called Dyal Capital Partners that subsequently raised $1.3 billion in a debut fund to pursue the strategy. These vehicles were structured similarly to a traditional PE fund, with LPs committing capital to be locked up for a decade or more; however, this time the alternative investment firms themselves would be the portfolio companies.

As these funds started doing deals, the pivotal question for all involved was how to achieve an exit. Many of the early investments were made into hedge funds, some of which went belly up. A handful of high-profile failures led many to call the strategy into question, but, despite some setbacks, LPs continued to enjoy their share of management fees and eventually exits started to come. A turning point for the GP stake strategy seems to have come in 2016, when the GS AIMS Petershill fund struck a deal to sell its remaining holdings to AMG for $800 million. Reports at the time showed the sale providing a 22% premium to Petershill’s investors, resulting in a 15% annualized return over the fund’s life.

Same game, new players

This sale seems to have served as a catalyst for renewed optimism about the strategy: Goldman launched two more Petershill funds, Dyal Capital has now raised a total of three vehicles devoted to the strategy, and new players are coming to the forefront too. Blackstone now has a fund called Blackstone Strategic Capital Holdings, Credit Suisse is planning a fund via its newly formed Anteil Capital Partners unit, Aberdeen has hired a handful of professionals to spearhead an upcoming $1 billion fund, and Carlyle’s AlpInvest has also dedicated resources to minority stakes (although Marek Herchel, who was tapped to lead the initiative, has reportedly left the firm). Other firms pursuing the strategy include Hycroft and the aptly named GP Interests.

As mentioned, some of the early GP stake funds took hits when hedge funds that they backed went under. The failures came for a variety of reasons, from poor performance and the departure of lead portfolio managers to regulatory violations including insider trading. The AUM of hedge funds can also fluctuate quickly, which can be a boon in good times but also poses a significant downside risk if redemptions occur en masse. To help mitigate this risk, many GP stake firms have been shifting their